Interest Rates are Dropping Again!
Since interest rates are dropping again, I thought this might cause some folks to wonder what causes this. So, here's an overview of how mortgage companies set daily pricing. There is much disinformation that exists on the subject. In fact, daily price changes for FHA/VA and conventional loans are very simple to calculate.
1) Where pricing is concerned, a mortgage company must minimize risk without compromising production volume. When a company sets daily pricing, it is in effect taking a position against the market. In other words, the company is offering a rate to a borrower while market prices are still fluctuating. Loan Officers face the exact same dilemma. Interest rate quotes to consumers must be competitive in order to drive production, however the price can't be so low that the loan is originated at a loss. In addition, when a mortgage advisor quotes a price, there is always a danger that the market may move and a price change occurs.
2) There is an inverse relationship between the price of bonds and the movement of interest rates. As interest rates rise, the price of bonds falls and vice versa.
For example:
Bond Price Discount points to consumer
98 2.00
99 1.00
100 None
101 1.00 rebate
As bond prices rise, the number of discount points the borrower must pay decrease. When the media speaks to a rally in bonds, they are indicating that bond prices have risen which pushes interest rates lower.
3) As loans are originated they are packaged and sold as mortgage bonds or mortgage-backed securities (MBS's). The amount of money that an investor will pay for a mortgage bond depends on the interest rate paid by the mortgagor and current market conditions. Ginnie Mae bonds are common, daily prices for different pools can be found in most newspapers. Whenever a borrower makes a mortgage payment, a portion of the payment is passed on to the holder of the Ginnie Mae security. It is the daily price fluctuations in the forward mortgage-backed security market that cause mortgage companies to change pricing daily.
4) Treasury bonds represent Government debt and not mortgage debt. Thus, mortgage interest rates are not determined by the price or yield of either the 10 or 30-year Treasury bond. Often there is a large disparity between the amount of movement of Treasury bonds when compared to mortgage-backed securities in any given trading day. Watching the Treasury market to determine daily changes in discount points is impossible. Period.
5) Most mortgage companies watch market activity for over an hour each day before setting daily pricing. Mortgage companies commonly set daily pricing based on the bond levels at 10:00 am eastern. Daily price changes are the difference between prices of the mortgage-backed securities from 10:00 a.m. ET. By subtracting the price of the mortgage backed security from the price at 10:00 a.m. ET the day before, you derive the net movement in discount points.
6) The Treasury market opens at 8:30 a.m. ET and the mortgage-backed securities begin to trade at approximately 8:40 a.m. ET each day. Many economic reports are released at 8:30 am eastern time, so wide price swings are not uncommon directly following the market open. It is imperative to know when important economic data is scheduled for release.
7) Mortgage bonds are priced in 32's. Each 1/32nd is equivalent to 3.125 basis points. It takes 4/32's to see pricing improve by 1/8th etc.32nds. Depending on how your company prices, you may see daily price adjustments for a movement as small as 1/32nd or 3 basis points.
8) Mortgage companies make money originating and servicing loans, not by "playing the market". Bond traders make a living trading bonds, but the secondary marketing personnel of mortgage companies trade bonds to displace risk. In fact, when regulators audit mortgage companies, large, consistent trading gains are viewed negatively.
9) Daily rate changes for loan programs other than standard fixed rate loans are more difficult to track. Often investors such as Banks and Savings and Loans will price adjustable rate products based on asset/liability needs, therefore the daily price changes do not necessarily track changes in bonds.
Hope this helps you understand mortgage pricing!
Senior Mortgage Advisor
Carolina Mortgage Company - 843-230-7929
Senior Advisor - Helping you GROW your business!
www.activerain.com./luckydog1 - SC
www.activerain.com/luckydog2 - NC
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Sam - this is a really good explanation of the market - I think they will continue to fall, once they have the new derivatives market figured out.